Cycle investing is a strategy where investors make investment decisions based on market cycles. All market cycles have similar characteristics. By understanding the characteristics and different phases of a market cycle you can estimate where the market is heading in the future.
No matter what market you are referring to, all have similar characteristics and go through the same phases. All markets are cyclical. They go up, peak, go down and then bottom. When one cycle is finished, the next begins.
Four Phases of a cycle
Cycles are prevalent in all aspect of life and range from short to long time spans. There is a life cycle of a man that lasts about 80 years to a grasshopper that lasts for a couple of months to planet that lasts for billions of years.
Regardless of the market they all have similar characteristics and go through the same phases. Markets are cyclical. They go up, peak, go down, and bottom out. The length of cycle varies but the different phases are the same
Most investors and traders fail to recognize markets cyclical nature and often get caught in the moment not recognizing that the market is on its way down. Even investors that understand an industry and supply and demand dynamics can have a hard time to pick a top or bottom. An understanding of cycles is essential if you want to maximize investment returns.
Here are the four different phases of a cycle and ways to recognize them.
Accumulation Phase
During this phase the market has bottomed out and the sentiment is very bearish (negative). Some early adaptors and smart investors have figured out that the worst is over and are beginning to buy. During this stage valuations reflect the general publicâs opinion and are very attractive. A lot of bargain deals can be found in this phases for those who know where to look. During this stage the market has typically gone through a long bear market and investors have thrown in the towel and given up in
disgust. During this stage in the commodity market commodities remain cheap but shortages have started to develop as demand has gone up while no one has added new capacity due to low prices and little profitability.
Early Mark-Up Phase
During this phase the market the market is beginning to move higher. More and more investors are jumping on the bandwagon. In this phase more traders are getting into the market and creating more volatility. The fundamentals are still intact, existing companies expand and new companies spring up to fill demand. There is still room for investors to make profits.
Late Mark-Up Phase
During the late stage of this phase the market is getting more media coverage. And more and more investors are jumping on to the bandwagon driven by fear and greed of being left out. During the end of this phase volumes increase substantially and valuations goes up way beyond historical norms. You may hear commentators on television justifying the higher valuations and telling you why itâs different this time. At this stage the smart investorâs starts unload their positions while the majority of novice investors are buying in to the market.
The fundamentals supporting the bull market are no longer intact. As a result of higher prices for an extended period of time a lot of as new companies have sprung up and new capacity has been added.
The market typically makes one final parabolic move when the last investors that have been sitting on the side line jumps in. The market is no longer moved by fundamental value, it is driven by investor psychology.
Investor sentiment goes from neutral to bullish to outright euphoric during the Mark-Up Phase.
Distribution Phase
During this phases of the cycleâs sellers take charge. Investor sentiment goes from bullish sentiment to mixed sentiment. On the news you may hear some investors calling for a bubble while others are telling you that this is an opportunity to buy. The market may go into a flat trading range for a short period. Markets in this phase often experience a sharp selloff followed by another lower peak.
During this stage emotions rule the day. Investors are struck by fear and re-inspired with hope and greed. The mixed emotions cause markets to me extremely volatile.
In the commodity market supply has caught up with demand during this phase and no longer warrant higher prices. As commodity prices starts to come down the producers becomes less profitable and their stock decline in value. Most companies are extremely overvalued and a correction is underway.
Mark-Down Phase
The last phase is extremely painful for those who still hold positions. A sharp selloff takes place during this phase and investor sentiment change from denial, to fear, to panic, and to capitulation.
Many investors hold on to their positions because they fallen below what they paid for them and in their denial they choose to go down with the ship instead of taking a loss. They may still have some vague hope that the market will come back to what it once was.
Smart investors who understand market cycles sell short during this phase, betting on a decline in the market.
The selloff phase is fast and brutal and quickly adjusts the priceâ¦